The case for rainy day funds

Wednesday

Mar 13, 2013 at 12:00 PMMar 13, 2013 at 12:48 PM

Michelle Singletary - The Color of Money

It's always good to have supporting documentation to back up the conventional wisdom.

Using data collected during the Great Recession, the FINRA Investor Education Foundation has produced some compelling evidence of what happens to people who don't have a rainy day fund for emergencies.

"Households that experience an income shock and have emergency savings are predicted to have a 9 percent chance of making a late mortgage payment, compared to 28 percent for households that experience an income shock and do not have emergency savings," wrote Gary R. Mottola, author of the FINRA report.

Not only that, you're nearly twice as likely to be involved in a foreclosure if you don't have an emergency fund. Some households are obviously more vulnerable than others. Those with incomes below $50,000 were 43 percent more likely to make late mortgage payments than their more affluent counterparts. Having dependents increased the likelihood of late mortgage payments by 48 percent.

It's not that any of this doesn't make sense. If you aren't making much money compared to the cost of living, it's hard to save. If you have children, their expenses also make it difficult to save.

There are a lot of organizations trying to assess how well people manage their money or make sound financial decisions. In a working paper for the National Bureau of Economic Research, Annamaria Lusardi looked at how financially capable Americans are.

Not so much.

"The findings from this survey paint a troubling picture of the state of financial capability in the United States," Lusardi wrote. "The majority of Americans do not plan for predictable events such as retirement or children's college education. Most importantly, people do not make provisions for unexpected events and emergencies, leaving themselves and the economy exposed to shocks."

We know that for many people, a drop in their income or an unplanned expense can hit hard. In its latest Assets and Opportunities Scorecard, the Corporation for Enterprise Development found that nearly half of households -- equivalent to 132.1 million people -- are "considered 'liquid asset poor,' meaning they lack the savings to cover basic expenses for three months if unemployment, a medical emergency or other crisis leads to a loss of stable income."

I know what you're thinking. Really, they have to study that people need a rainy day fund. Isn't that common sense? Don't people know they should save in case of an emergency?

Yes, many do. Still, I like providing proof and, more importantly, a drumbeat of reminders that if you can manage to stash some cash, when a financial tragedy happens such as a divorce, health issues or, of course, job loss, you have some money to tide you over.

"While experts have long stressed the importance of rainy day funds, our study controls for other variables and isolates the positive effect that emergency savings can have when encountering a financial crisis," said FINRA Foundation President Gerri Walsh. "For example, having rainy day savings can offset the increased risk of late mortgage payments for low-income households with children when they experience an income shock. In short, rainy day funds can benefit households that are vulnerable to mortgage problems. Because the data we used was taken during the largest housing downturn in decades, we know that rainy day funds work in a financial storm."

So I asked Walsh: What now? What should people do with these findings?

Act, she said.

If you haven't already, automate the way you save. Have money withdrawn from your paycheck much as you do your taxes to build up your emergency fund. Keep it separate from the accounts you use to pay your monthly expenses. This has certainly helped people save for retirement and even college.

"If more Americans could automate the funding of a rainy day fund, such as through payroll deductions to a separate bank account, then we could extend the automated model to foster emergency savings," Walsh said.

But we understand. The economy is still tough. You may be facing a furlough or perhaps you just found a job and you're playing financial catch-up.

"Many families are having trouble making ends meet, and for some families accumulating a large rainy day fund is just not realistic," she said. "But even saving $10 a week for a year could help you fix your car if it breaks down. Even a small emergency fund is better than nothing."

Let me put it this way: It recently rained heavily where I live and all I could find rushing to get to my office was a small umbrella that kept collapsing when the wind kicked up. I got wet. But I didn't get drenched.

Readers can write to Michelle Singletary c/o The Washington Post, 1150 15th St., N.W., Washington, D.C. 20071. Her email address is singletarym@washpost.com. Comments and questions are welcome, but due to the volume of mail, personal responses may not be possible. Please also note comments or questions may be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.